Loss-Absorbing Capacity: The Last Remedy for European SIFI Regulation?

Abstract

Versatile regulatory approaches exist for Systemically Important Financial Institutions (SIFIs) in the European Union (EU). Bail-ins of SIFIs, however, are still not deemed credible. This analysis starts with the primary purpose of SIFI regulation, explains the destruction of asset value arising from the fire sales that are SIFI bank runs, and introduces a “loss-absorbing capacity” approach to orderly bank resolution in the EU: the Minimum Requirement for (own Funds and) Eligible Liabilities (MREL). Comparable to its international equivalent—Total Loss-Absorbing Capacity (TLAC)—it requires SIFIs to have enough subordinated liabilities with loss-absorbing capacity for lowering barriers or impediments to bail-ins. The article then provides answers to the questions of the responsible supervisor, the supervised entities, characteristics of eligible liabilities, and the economic impact of the regulation. Both concepts MREL and TLAC are then compared. Finally, shortfalls such as the lack of liquidity and recovery for banks in distress, and a pro-cyclical effect are discussed, since they counterfeit the intended implications of those proposals on ending the phenomenon of firms being too big to fail.